Options Traders Must Measure Risk versus Time versus Opportunity

Sean McLaughlin
July 13, 2018

I love getting questions from our subscribers to All Star Options. It shows they are engaged and eager to learn or to get clarification as they learn our processes. We get questions every day. Here's one I received recently that I thought held a lesson we could all benefit from:

Question:

I have a question about considering time horizons when selection which options to purchase. Often with naked long calls, the trades aren't necessarily wrong on direction, but wrong on time frame. What is the downside to going long calls further out in time? For some, if the ideas that didn't work out time wise, would you roll out another month or two if the chart is still saying it's ok to be long?

Answer:

There isn't any "downside" on going further out in time. It's just a trade off. You'll spend more money in premium and therefore have more to lose if you're wrong, but you have more time to be right. You'll have to decide what's more important: limiting your max risk, or giving you more time to be right (profit)?

When you get inside of 21 days to expiration and you're holding long options that aren't working, it's best to close them out because theta will really start burning your premium as you get closer to expiration. If you're still bullish and can identify a catalyst for further upside, there's nothing wrong with re-establishing a new position at a new strike in a further out expiration when the proper set up arises.

Question:

I’m bullish XYZ and think they are going to crush earnings.  I don’t like the naked calls though given the premium prices. I’m curious if you’d do a vertical call spread?

Answer:

If I don’t want to pay higher premiums, a good choice is often to sell a further out-of-the-money option against my intended long strike to lower the total net cost, creating a long vertical spread. But with everything, there is a trade off. In this case, if I totally nail XYZ stock and it takes off, my upside will be limited.

When premiums are elevated, my preference is to be a net seller of options. So in this case selling a naked put or a put vertical spread might make sense. But in seeking a higher probability of making money, you’ll never hit a home run because no matter how high XYZ climbs, the most you can make is the premium you collected at entry.

Every decision is a trade off and there’s really no one “right” answer :

@chicagosean

Filed Under